Long Put Option Strategy

‌A long put option strategy entails purchasing a put option by itself. Investors with an investment objective of speculation and capital preservation utilize the long-put option strategy. A put option gives the investor the right to sell a stock at the strike price within a specified time-period. The put option gives the investor flexibility to sell the stock at a later point in time if the price declines in value. For this, the investor pays a premium for a put option which gives the right to sell 100 shares of stock.

The maximum upside potential in a long put is the strike price less the premium. The maximum potential loss is 100% of the amount invested in the long put option. A long put option strategy therefore requires a considerable level of risk tolerance. An investor who has a bearish outlook that anticipates the stock price to decline beyond a certain price by a set-date utilizes a long put option strategy.

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Let’s See an Example:

An investor anticipates that the stock price of EIO will decline in the next 3 months. EIO trades at $10 while a 3 month put option with the $10 strike price trades at $2.

The investor buys one EIO put option at the $10 strike price with 3 months until the expiration date for a premium of $2.

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The maximum potential profit is the strike price of $10 less the $2 premium received multiplied by 100 shares. This is calculated as follows:

Maximum Profit per Option = (Put Option Strike Price - Premium) x 100 shares

$800 = ($10- $2) x 100 shares

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The maximum potential loss is the premium of $2 paid for the put option multiplied by 100 shares. This is calculated as follows:

Maximum Loss per Option = Premium Paid x 100 shares

$200 = $2 x 100 shares

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The breakeven point is the $10 strike price of the option less the $2 premium. This is calculated as follows:

Break Even Point = Strike Price - Premium Paid

$8 = $10 - $2

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The profit and loss of the long put option strategy until the expiration date is depicted in the chart below.

The chart shows the potential profit and loss on the y-axis versus the corresponding stock price in the x-axis until the expiration date.

If EIO trades remains above $8 and beyond, the investor will take a loss anywhere between $0 and $200. If EIO trades fall below $8, the put option strategy becomes profitable with a potential maximum gain of $800 if the price goes to zero. The breakeven point is $8, which is the strike price of $10 less the premium paid of $2.

If EIO falls below anywhere between $10 and $0 during the duration of the option contract, the long put holder can exercise the option. This means the investor would sell 100 shares of EIO at $10. If the investor holds shares of EIO long, the shares would be sold at $10. If the investor wishes to capitalize from the decrease in EIO’s share price without having to exercise the option, he can sell the option at a gain once the price falls below $8 a share.

If EIO remains above $10 the option will expire worthless and the investor permanently loses the $200 invested.

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